Junk bonds by another name...still bring down the economy


For those who remember Mike Milken and the junk bond scandals of the 1980s, the mortgage crisis has a familiar ring. Although the general public thinks of Milken as an "insider trader," the bigger racket, as Ben Stein pointed out in the fantastically educationalLicense to Steal, was more about creating a market for junk bonds and not being accurate about their default rates.

Milken said that his junk bonds had a default rate of only about 1%. That sounds fantastic. Imagine: normally you have to take a higher risk to get a higher return. Milken basically told people that they could have both low risk and high return by charging companies high-risk rates. Magically these companies that were willing to pay the higher rates wouldn't really be a higher risk of default.

In reality, the default rate became much higher because Milken was lending to companies that weren't that strong.The default rate went up to at least three, maybe 5%. That's why Milken's junk bond world fell apart. The same thing has happened with subprime mortgages. Only this time there isn't a Milken-like figure to blame. There's no one person that was hyping this market. There are just the rating agencies.